Pinnacle West Capital Corp (PNW) 2005 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Pinnacle West Second Quarter 2005 Earnings Call. After the speakers remarks there will be a question and answer period.

[Operator Instructions].

Becky Hickman, director of investor relations, you may begin your call.

I would like to thank everyone for participating in this conference call to review our earnings for second quarter and recent developments. Today I have with me Bill Post, our chairman and CEO, Jack Davis who is our President and COO and also President and CEO of Arizona Public Service, and Don Brandt, our CFO. Before I turn the call over to our speakers I need to cover a few details. First, the quarterly statistics section of our website contains extensive supplemental information our quarterly operating statistics.

Second, please note that all references today to per-share amounts will be after income taxes and based on diluted shares outstanding. It is also my responsibility to advise you that this call will contain forward-looking statements based on current expectations, and the Company assumes no obligation to update these statements. Because actual results may differ materially from expectations, we caution you to not place undo reliance on these statements. Please refer to the MD&A in our March 2005 10-Q, which identifies some important factors which can cause actual results to differ materially from those contained in our forward-looking statements.

A replay of this call will be available on our website, www.pinnaclewest.com, for the next 30 days. It will also be available by telephone through August 3rd. Finally, this call and webcast are the property of Pinnacle West Capital Corp., and any copying, transcription, redistribution, retransmission or rebroadcasts of this call in whole or in part without Pinnacle West written consent is prohibited. At this point, I will turn the call over to Bill.

Thanks Becky. I would also like to thank you for taking your time to join us today. We know this is a busy week for earnings announcement and we thank you for taking your time. Before we get into details of the call, I would like to thank you for concern during my recuperation from surgery. Bottom line is that a planned operation with four weak recovery turned into a 3 month effort due to a failed surgical process. However, I am happy to tell you I have fully recovered and the original goals were achieved, and I do have some new guidance for you. And that is, to avoid hospitals as long as you can, and I am very comfortable predicting this is permanent guidance.

Seriously, I thank you and look forward to seeing you next month. We had a very productive second quarter and I would like to highlight a few milestones we achieved before I turn the call over to Don and Jack, to discuss the details of our financial results, our operations and our regulatory development. Our retail customer growth continues at a remarkable pace, about 4% annually ranking as second in the country. In fact, we expect to announce within the next few weeks that we have added our millionth customer. The retail rate settlement became an effective April 1. Along with the settlement's other terms we put a 4.2% rate increase and a power supply adjuster, a PSA in place.

Both measures bolster our financial strength. Last week, we filed our first application for PSA a surcharge. Jack will give you more details on that filing. We received approvals from both the Arizona Corporation Commission and FERT to transfer the Pinnacle West energy generating plants in Arizona to EPS, thus uniting the assets serving our retail customers. We expect to complete the transfer in the next few weeks. We completed the purchase of the 450 megawatt Sundance Plant and issued a request for proposals for more than 1,000 megawatts of long-term resources to secure commitments to meet our customer's long term needs.

We announced the sale of our share of the Silverhawk Plant in Nevada, thus closing out our merchant generation business, once final regulatory approvals are received. And, we sold 6 million shares of common stock in late April to improve APS' equity level and help fund capital expenditures needed to reliably serve our customer base. Our earnings outlook for 2005 does not change. Obviously it does not reflect either the regulatory disallowance we will record as a result of the recently approved settlement of (inaudible) or the financial effects of the announced sale of Silverhawk. Now, I'll turn the call over to Don, who's going to discuss second quarter or earnings. Don?

Thank you Bill. Today I will review our financial results for the second quarter and the significant changes from last year's comparable quarter. I will also update you on our financing activities. In my comments, whenever I refer to earnings related amounts in millions of dollars, I will be referring to amounts after income taxes unless I say otherwise. We reported net income of $27 million or $0.28 per share for the quarter compared to $73 million or $0.79 per quarter in the second quarter of 2004. The quarterly comparison was unaffected by a few unusual items related to sales of non- core investments.

These items included a loss of $0.61 per share related to the sale of the Silverhawk plant we announced last month, a gain of $0.23 per share in the sale of the Phoenix Suns and the second quarter of 2004, at a loss of $0.03 per share from discontinued operations at both Silverhawk and NAC in the second quarter of 2004. Excluding the unusual items, our ongoing earnings were $86 million or $0.89 per share in the second quarter compared with $54 million or $0.59 per share in the comparable quarter last year. Several factors favorably impacted the ongoing quarterly comparison.

A retail rate increase, deferred fuel, and purchased power costs lower depreciation expense. All of these resulting from ACC rate settlement and then a 4.2% customer growth, the absence of regulatory asset amortization, and improved results from SunCor. The positive factors were muted somewhat by higher operating costs primarily related to generation, customer service, and benefit costs. I will review the details of the major variances and earnings for the quarter.

First, the economy in Arizona continues to be strong. Retail sales growth is robust and is the basis for our long term performance. Our customer growth has consistently been 3 times the national average. Customer growth was 4.2% in the second quarter 2005, our highest level of growth since 2000. Arizona's population and job growth continue to be the top in the nation. We expect this level of growth to continue in the foreseeable future. The growth translated to an increase of $0.08 per share. The retail rate increase became effective April 1st and added $0.17 per share.

We also implemented the power supply adjuster at the beginning of the quarter. The decrease in reported and purchased power and fuel costs, because of cost deferrals improved earnings $0.05 per share. As a reminder, our new base rates reflect fuel costs at 2003 levels. We concluded the amortization of substantially all of APS' regulatory assets in the second quarter 2004. The absence of this amortization in the second quarter this year, improved our earnings $0.06 per share. As part of the recent ACC settlement, we lowered depreciation rates for certain types of plants. Reduced depreciation expense improved earnings $0.06 per share in the quarter. SunCor's earnings were up $7 million or $0.07 a share for the quarter.

These positive factors were partially offset by 2 items. First, higher O&M expense decreased earnings $0.09 per share compared to the prior-year quarter. The increase is consistent with our plan for the year and is due primarily to higher planned maintenance of overhaul cost in our generating plants, increased customer service costs to support growth, and for planned T&D maintenance, and higher employee benefits costs.

As I mentioned in last quarter's call, we had planned to see this pattern of O&M increases in both the first and second quarters of the year with the second half of 2005 relatively flat when compared to the second half of 2004. Secondly, marketing and trading of gross margins were down primarily because of lower unit margins. This factor decreased earnings $0.06 per share.

Now, I will turn to updating you on our commodity risk-management activities in the western energy markets. We have currently hedged approximately 85% of our remaining 2005 exposure to purchase power and natural gas commodity price risk for native load requirements, and we continue to add to the heads. Similarly, we have hedged approximately 75% of our 2006 price risk. Our hedged positions are at prices substantially below current forward market prices for the balance of 2005 and 2006.

The western energy markets continue to be affected by high prices for natural gas and healthy amounts of generating capacity. Compared with the second quarter last year, natural gas prices were up 12% and on peak spot prices at Palo Verde were up 6%. Spark spreads in the spot market have declined about 6%. Market conditions continue to put pressure on forward sparks spreads. Since the end of the first quarter, on peak sparks spreads declined slightly for the balance of 2005 and all of 2006.

Now turning to our financing activity and liquidity. Bill mentioned our issuance of 6 million shares of common stock - The net proceeds were $248 million. We're investing the proceeds in APS to fund capital expenditures including last quarter's acquisition of the Sundance Power Plant. APS and the parent company are both in strong liquidity positions. APS is currently invested approximately $500 million, which is primarily from the repayment of the Pinnacle West energy inter company loan that we discussed with you last quarter.

APS intends to the use the loan repayment proceeds in connection with the Pinnacle West generating asset transferred that is expected to be completed shortly. APS also plans to repay $300 million of the 7.625% notes that mature next Monday, August 1st. On May 2 the parent called at par $165 million of floating-rate notes that were due November 1, 2005. We used cash on hand to redeem.

The parent company has currently invested approximately $150 million. During the quarter both Standard & Poor's and Moody's affirmed the ratings of all Pinnacle and APS debt securities and returned the ratings outlook to stable. In doing so, they cited our improved risk profile and our demonstrated intent to improve our financial strength. I will now turn the call over to Jack.

Thanks Don. Today I will update you on the highlights of our operation performance and regulatory developments. As Bill said, the second quarter or so, has been a busy time with lots of progress. First let me discuss regulatory development. Notably, the terms of our retail settlement agreement went into affect April 1st. Among other things, these terms included a 4.2% price increase and implementation of a power supply adjuster.

In accordance with the PSA, we have been deferring 9% of the difference between our actual fuel and purchased power costs and the based fuel rate of 2.0743 cents per kilowatt hour included in our base rates. As Don mentioned, the base rate fuel approximate our 2003 costs. We will make filings with the ACC each spring to establish a PSA adjustment. However, we're required to request a PSA surcharge when the accumulated deferred balance is between 50 and $100 million. We passed the threshold for surcharge filing earlier this month. Consequently, we filed a request with the ACC last Friday, for a PSA surcharge to become effective for the first billing period this November.

As proposed, the surcharge would be an average of 2.2% temporary increase for a 24 month period. To recover $100 million of deferred fuel and purchased dollar (ph) costs. As most of you know, the settlement included the ACCs approval of transferal of Pinnacle West Energy generating plants to APS - in Arizona to APS. On June 15th, we received a similar approval from Fert. We expect to complete the final transfers in the latter part of August.

We're still planning to file a general rate case late this year, with the goal of getting a decision from ACC by the end of 2006. Now, I would like to turn to growth of our market and meeting the resource needs for our growth. Our retail customer growth continues at 4% annually. Our customer growth is underpinned by Arizona's population growth which is 3 times the national average. Historically, we have successfully met the challenges of reliably servicing our -- growth customer service territory and will continue to do so in the future.

In light of our remarkable customer growth, long-term resource planning and acquisition are major activities for our Company. In May, we completed the acquisition of the Sundance Power Plant south east of Phoenix. The plant gives us 450 megawatts of very flexible peaking capacity. Even after the purchase of the Sundance Plant, we expect to be short some 1,200 megawatts by 2007. Through the rest of the decade, we will need to continue at peaking capacity in addition to the 1,200 megawatts.

Therefore, also in May we issued 2 requests for proposals for this year. These RFPs were issued in accordance with the terms of our settlement agreement. The first RFP was for 100 megawatts of renewable resources with the proposed delivery date beginning in 2006. The second RFP was for at least 1,000 megawatts of capacity with delivering beginning in 2007. Because of confidentiality agreements with the bidders under both RFPs, I cannot share with you much about the proposals we received. Here's what I can tell you, responses to both were strong.

We short listed certain renewable bidders in mid July and we have begun our analysis of the liability proposals that we received 9 days ago. We expect to complete the selection process for both RFPs this fall. It goes without saying that, we will be working to get the best deal for our customers and the need to our system.

Our needs for additional capacity -- a need for additional capital for new capacity beyond the Sundance Plant, will dependent on the outcome of our bidding process, since it will establish the portion of our need to be supplied through purchase power (ph) contracts, versus plant acquisition. But, I should remind you that our settlement requires us to get Commission approval if we're going to acquire a plant. Next, I will briefly review some of our operating activities.

On July 18th, set a new system peak of 6,857 megawatts so far this year. This peak reflects a 7% increase over last year. On a (inaudible) basis that peak grew some 5% compared to last year. I do not know whether we have seen our final peak for this year. This summer we have had 19 days with temperatures above 110 degrees, but we have not seen the mixture of heat and humidity that usually causes us to peak, more may be coming.

Looking at our power plant performance, the capacity factor for our nuclear plants was 67% in during the second quarter, compared with 77% in the second quarter a year ago. The decrease in the capacity factor resulted from unplanned (inaudible) related primarily to the replacement of pressurizer heating elements and reactor cooling pump, plus assembly oil seals on Unit 3. We are unwavering in our emphasis on safety and operational excellence at those plants, and we complete an extensive analysis to identify and resolve the root cause of each problem we have there.

We believe, that Palo Verde is well positioned to continue to be one of the country's safest and most reliable energy producers. Next (inaudible) with Palo Verde will be in Unit 1this fall. It is planned for 80 days, because we will be replacing the steam generators. Unit 1 will be the second unit completed in our steam generator replacement plan. Our coal plants operated at an average capacity factor of 83% during the second quarter, continuing their record of solid performers. And, our gas plants posted an admirable capacity factor averaging 27% during the second quarter. Our combined generation fleet gave us operating flexibility and control to meet customers' needs during the quarter and manage our costs.

This time last year, I talked to you about (inaudible) transmission substations that significantly reduced transmission import capability into the Phoenix load pocket. We restored their substations service in 3 phases. The first 2 phases were restored within 35 days of the fire, allowing us to complete our peak summer period last summer. We had new transformers manufactured to complete the final phase of the restoration for this summers peak.

The new transformers were installed on the final phase the west wing was energized on July 6 of this year. In June, APS received national recognition as best customer service team in 2005 American Business Awards, in New York City. This award recognized the great cross channel communication of teamwork required by all parts of our organization (ph), as we focus on delivering for customers each and every day.

Recently -- we received further recognition for its superior customer service came last week when received ratings from JD Power and Associates based (ph) Residential Customer Survey. Once again, APS was ranked No. 1 in customer satisfaction among all investor owned utilities in the west, and furthermore, we ranked in the top 5% of all investor-owned utilities nationally. In summary, our employees are tenaciously focused on providing excellent reliable service to our customers at reasonable prices. At the same time, they emphasize safety and efficiency. That concludes my prepared remarks, I will turn it back over to Bill.

Thanks Jack. As Jack said, we worked aggressively to meet the challenges of growth. There are many, many facets of our business on which our employees focus every day. Providing exceptional customer service, maintaining strong operational reliability, controlling costs, working safely, and the list goes on. In summary, I believe our tremendous customer growth and the related potential for earnings and dividend growth are distinguishing characteristics of our Company. We will endeavor to continue to capitalize on these advantages. That concludes our prepared remarks, and we would be happy to take your questions.

[Operator Instructions].

Your first question comes from Dan Eggers with CSFB.

I guess because this PSA is still fresh, I'll ask you questions to make sure I have my arms around this. Number one, at the end of the second quarter you deferred balance was 34 million and then you said in July you broke through that 50 million barrier. What sort of deferred fuel cost exposure are you guys adding on a weekly basis right now?

I do not know the number on a weekly basis. I can tell you we will cross the 100 million threshold after August. So, if I take 100 million and subtract off 55 million we say (ph), during the month of August it's somewhere around 40 to $45 million.

So about 10 million a week?

Yes.

And the gas - presuming that's all predominately gas driven. The gas you're buying is hedged at this point so, there's good visibility of what that difference will be to address the year?

Yes Dan, Don speaking. For the balance of the year 85% hedged and that tends to be a higher number on the summer months. We have that locked down pretty well.

In our filing that we made on Friday we quantified, but for the hedges the deferred costs would have be $25 million higher.

Got it. For the rest of the year, for September, October, November, December we could reasonably look for another 60 to $80 million of make up to be had?

No, that would not be true. When you get in that period of time our load is way, way down. So, we will be in a single digit kind of number during those months.

Dan, you really cannot extrapolate that 10 million a week past August. September will be a completely different number. We cannot give you a weekly number that you could use through the rest of year because it is so volatile.

I understand. I was just looking at the 34 million you guys did in the second quarter and I was trying to extrapolate what that could be over the rest of year.

Remember, the second quarter has the month of June in it which it begins our peak usage period.

What is the total ceiling you guys can do under your PSA? It is 6 --how much?

It is $786 million total fuel purchase prior cost for the year.

That is not for the year -- is that per year or the overage until ...

... That's for the year.

Okay. One more question on the RFP as it stands right now. You guys have -- one of bids in. Had you seen much of a change in the character of conventional bid this time around versus last time? I remember last RFP they were awfully high bids. Have people gotten a little more rational about how they are bidding their generation this time?

I can't divulge -- that specific information. All I can tell you is that we have more than enough bids to cover a shortage.

Thank you guys.

The next question comes from Steve Fleishman with Merrill Lynch.

Hi, everyone. A couple of questions, just also to clarify on the bidding process. Are these all bids for power contracts as opposed to someone bidding in actual plants?

Steve this is Jack. The bids we got on the reliability piece are all kinds whether it's power purchased contracts or assets or - so it's a mixture of all of those.

So, it is possible that you could take a bid that includes an asset?

That is true. If I did that I would have to go to this commission and get approval to purchase that asset. Which is - if I were going to do that it is actually a good thing.

Okay and if then - if you got approval, do that approve for recovery as well or doesn't have to be dealt with in the next rate case?

It would probably done with the next rate case Steve, but obviously if they approved it that would be certainly difficult to overturn later down the road.

Right so, it would be a timing issue? If an issue at all.

Right.

Okay. Second question would be on the real-estate business SunCor? You were up $0.07, is that just timing of land sales?

Pretty much so, Steve. Don speaking. Part of our guidance is we're assuming 50 million for SunCor. We are on target for that.

Any sense of when you're going to be updated the SunCor plan given that it has been really, as you said yourself, 2 years since you really gave it and obviously real-estate markets have been doing their thing?

We're going to do that later this year. We have been on the plan actually since September of '01 when we outlined a 3 year exhilarated accept a plan for SunCor. that ends the end of this year. We have been working on a plan for SunCor for the bulk of this year. Just to give you a preview of that, we looked at it from a completely different perspective than we have before with a focus much more on our weave (ph) and the traditional developer real-estate approach. We will be able to talk to you about that plan later in the year.

Okay. I guess finally on the -- Don, you kept talking about spark spreads in Palo Verde being blow, weak. From all the information you get, is it your sense that's an actual issue of oversupply or an issue of just a very small spot market and that everything in the West is really trading through bilateral contracts?

I think on the bilateral side their relatively short term that the sparked spreads are pretty skinny.

Okay.

To more directly answer your question, I think it is more driven by the supply situation. And until that is consistent with what we have been saying, at least our opinion, until we get a couple years down the down the road before some of that gets sucked out, it is a phenomenon that we will live with now. In a few weeks when California starts getting into their peak season, all bets are off. Things could happen. We had some tight situations in California as we have across the country in the last 2 weeks, assuming normal weather patterns we expect the trend to continue.

Okay, thank you.

Your next question comes from Zach Schreiber with Duquesne Capital.

Hi Don, hi Bill it's Zach Schreiber from Duquesne Capital Management. Bill, I'm glad you had a full recovery.

Thanks Zach.

Just a question about spark spreads, I guess probably for Don. Don, we all keep reading research about resurgence in western spark spreads. Are we just looking at a different market? And is there a different market in Arizona than there is in Southern California or in (inaudible)? Because from all the work but we do and read, it looks like spark spreads are actually expanding.

The heat waves aren't moving, but the low heat rate guys are getting expanded sparks spreads compliments of gas prices exaggerating their heat rate advantage. So, are you saying that heat rates aren't moving or are saying that spark spreads are really skinny in Arizona versus other western markets of the (inaudible)?

I think we got a poor connection but I think I got the gist of your question.

Is this better here, can you hear me now?

Yes, that's quite a bit better.

Sorry about that.

The market I'm talking about is the west. It is not unique to Arizona, at least Southern California and the desert southwest. Like I said, we have seen gas prices go up 12%, and power prices have ticked up about 6% and so, that is a compression of spark spread.

Is that on a structural basis or is that sort of for a (inaudible) or is that just on a month- to-month basis?

On pretty much the quarter basis.

Okay, that's helpful. Second question is on this 90/10 sharing on the fuel clause (ph) and the PSA. Did that cost you anything? With gas prices going up and having to eat that 10% difference, or I recall there was some metric in there where you got to use the wholesale sales to subsidize that, did the wholesale sales fully compensate you for that or was that 10% on the PSA a positive or negative in the quarter?

The 10% Zach, is not offset by Off-System Sales. That was the -- the total 10%, was net net a negative, and it was somewhere in of 4 to $5 million on a pretax basis our cost in the second quarter.

There were some regulatory measures that you had that would let you get recovery of something as long as you were not over earning? I forget if that was the deferral mechanism for Sundance or (inaudible) to do with the PSA. Is there any process of recovery of that 4 to 5 million or is that sort of the deal that you cut and have to live with it? And if it is really the Sundance mechanism that had the ROE tie in?

We have to live with it.

Got it. Now on Sundance following up on Steve's question, you had approval to purchase it, but was there anything in that approval that prescribed the rate treatments or -- what did they approve when they approved it? Did they prescribe the rate treatment or was that all -- to be decided in the fall of next year?

This is Jack. They did not pre-subscribe the rate treatment. All the filing that we make in the fall of this year will include the inclusion of Sundance into our base rates.

Got it. On the regulatory front, has there been any noise about filing the PSA, or are folks saying that this is the deal we cut, and we understand that gas prices are going up, their backing the fuel clause this is the bargain and there is some sort of re-regulated and there is no one making any noise about it?

There was one article that appeared on Saturday morning after our filing on Friday, and there's on (inaudible). I can generally say that I would view that article is being primary plain vanilla. There was not anything outrageous on either side of the issue. It was mentioned in there by commissioner Spitzer that everybody recognizes, I think the term he used is, gas prices are skyrocketing.

On the RFP, what is the timing of the RFP? You mentioned that you would like to maybe buy an asset. I imagine that way you would get something that will earn a return (inaudible) sort of committing capital with no ability to earn a return on it. How does all that tie in on the R F P? Are there sellers of these assets who are bidding the RFP, or willing sellers of assets or just power? And how does all that play out and what is the timeline on that?

Zach, as I mentioned earlier, the kind of business we got were all kinds were they were power purchases or asset purchases. To the extent that the best long-term proposal would be an asset purchase, under the agreement we would have to go to this commission and get approval for purchasing that asset before the asset got purchased.

Does the agency have any predisposition toward you guys owning it or not? My understanding was that they were kind of mixed on that. They wanted to regulate but they wanted to keep open this sort of hope for deregulation and mandate that the RFP be put out there to wholesale. Have they now changed where they were actually predisposed to you owning those assets or do you think that, there is no predisposition on their part one way or the other and it's kind of all economic?

The RFP obviously was a piece of the settlement, which addressed the issue of a robust wholesale market.

You're right.

In terms of there being any predisposition of us owning an asset or not owning an asset, I don't think there is any predisposition, it is just that if we want to purchase the asset, as we did in Sundance case, they want us to come to them to get the approval to do that.

I think the only predisposition that they would have Zach is lowest cost to the customers. So it comes back to your economic theme.

Got it. Okay. And then, on the equity infusion, when are you going to ask earn a -- what is the equity ratio now at APS with all the cash and what is the equity ratio in your last rate case, and what kind of regulatory proceedings are you going to try to close that gap?

As we mentioned in the first quarter call in the common stock issuance, we expect once we close the Silverhawk transaction and infuse that cash in, APS would have an equity ratio, book equity ratio of about 53%. And after you factor in the off- balance sheet lease obligation bonds we're at about 50/50.

And then wouldn't you try and get recovery on that? Is that in the next rate case?

Yes

The Sundance rate case? Okay, sorry for all the questions. Real-estate, what's the net book of value, of real-estate?

You have to ask that again, we couldn't ...

...I'm sorry, on the real estate what is the net book value of the remaining assets?

You're still breaking up.

I'm sorry. Can you hear me now? On real-estate what is the net book value on your residual real-estate holdings?

Zach, we do not have that with us here, but I will call you back.

Okay, and then on Palo Verde could you talk to us, I know you guys have less risk (ph) to it now, than others do, given the PSA, but what is going on with Palo Verde and what are we doing to ensure that it is going to sort of live up in the future to it's great history and it's great operations historically? Is there any thought that Palo Verde has to be part of a larger organization to be able to compete? How do you guys get comfortable? How should we get comfortable with that? It's going to be the great plant in the future that it's always been historically? We sort of always read little things about it that aren't so flattering.

Zach, this is Jack. I guess the first thing I want to say is, whether or not we have a PSA has no bearing on how we are going to operate the plant. We will operate the plant to maximize output in the safest way we can. The PSA has no bearing on that whatsoever. The bump in the road we have in the second quarter, quite frankly was the result of the decision by (inaudible) management which I endorsed to say that that we had this issue with the pressurizer heater, and we could either live through this baby through the summer and maybe have the (inaudible) in the middle of the summer or, we can take a more prudent and safer decision and take the unit out now in order to get it prepared for the summer peak. Of course, it was on during our summer peak period. That was the basic decision that had to be made.

I got it. That is actually a very good decision. Okay, I'll follow-up on the line guys. Thank you for indulging me.

Thanks Zach.

The next question comes from Vedula Murti with Tribeca Global Management.

I was wondering following up on the PSA question, you mentioned the cap is 786 right now. Right now given your deferrals and surcharge you are asking for, what are you estimating that you will come in at relation to that 786 for 2005?

Let me answer it this way Vedula, Don speaking. Under any reasonable scenario that -- the 786 will not be a factor in 2005 or 2006.

And when you go and file for the actual increase as opposed to the surcharge to the fuel tariff, will that then raise the 786 going forward in terms of what the cap is?

This is Jack. The whole issue of the cap was put in there in order to incent us to come in and file a rate case. My opinion would be that in the rate case itself the 786 will not have any bearing whatsoever.

I guess -- maybe so I understand clearly, the 786 cannot be changed independently of a full cost service proceeding?

No, let's put it this way. It was put in there to have us to file a full cost service proceeding. There was nothing to prevent us to say -- the proceeding is not completed yet but we are buffing up the 786 to ask for a waiver. We could always do that, knowing that the data is sitting right there in front of the commissioner.

Perhaps I will follow up offline. I was trying to make sure that in terms of cap there is not a way that if, for instance through the other parts of the business if a rate proceeding on your behalf was not required but you needed to raise that cap that you can do that independently of the full cost service proceeding.

You're postulating something debt would not be there, because we will follow the rate case. So, what I'm saying is all the data would be there. In the extent the case was not completed prior to reaching the 786, independently we can ask for a waiver of that 786.

Okay. I also just want to reiterate Don said under any reasonable scenario at this point, breaking through the 786 is not a realistic possibility for either 2005 or 2006?

That is correct.

And by that I meant gas prices, but we got 85% for '05 and over 70% for '06 locked in. So, mathematically it would be very difficult. Under both gas price scenarios and customer growth scenarios, to come up with any numbers that would factor out above that number in '05 or '06.

Thank you very much.

Thanks Vedula.

Your next question comes from David Thickens with Deephaven Capital Management. Mr. Thickens has withdrawn his question, your next question comes from Danielle Seitz with Maxcor Financial.

I was wondering what the average availability factor that you anticipate for Palo Verde for this year and next year?

Realizing that this year we have a -- extended outage...

...Right taking into account the outage.

...It would be in a high 80% capacity factor.

Okay still, okay. And for next year?

And next year it would be a normal fuelling cycle, 2 (ph) fuellings per year. In that particular case we would be in the -- in other words, next year would not have a steam generator replacement, so will be planning on the issue of the low of 90%.

I just could not figure out, what was the - how much of a declining factor you would have because of the outages. Because you can pass through particularly all of the purchase power etc., does that have as much of an impact except for Off -System Sales, I suppose? The Off-Systems Sales are being affected, but that is it, right? In terms of the 10% difference in the availability factor, would have an impact an impact on your earnings.

The bottom answer I think is no, because basically we are not selling out of Palo Verde, so that's Off-System Sales in Palo Verde don't really exist, those go to our customers.

Okay. And in addition to that, purchased power costs that you are incurring during those outages are being recovered correct? So, actually the difference is not going to be as major?

Let me change one thing, they are being deferred. So, the recovery will be decided in a future case. But yes, there in the process of being deferred given the earlier discussion that we had on the 10%.

Right, right. And at the other thing about the RFP, I am assuming that it will take a very large amount for you to have a for the purchase power level relative to what you are yourself generating for that to have an impact on any rating correct? It would have to be much larger than what you visualize now.

Danielle this is Jack. I think -- put it this way, if your concerned about the purchase power price as a result of the RFP banging against that 786, that is in Don's estimate that he gave you already.

Right. And I was thinking because rating agencies tend to feel that a very large amount of purchased power will be equivalent to more obligations. This could never come into play in your case because the amount would be too small correct? Relative to the amount that you are generating.

Generally, I think that is true.

Okay. Thanks, that's it. Thank you very much.

The next question comes from Brooke Glenn-Mullin with JP Morgan.

Yes good afternoon. I've got a few questions about the surcharge that your filed for. First of all, can you just walk us through the process of how it works from now that you filed, through to final approval? And also, is there any sort of time requirement for the commission to actually respond to your request?

This is Jack. Generally process works like this. We made a filing with all the supporting information and ask for the filing to become affective in the first billing period in November, which is the winter billing (inaudible) for our customers. In the intervening process Commission staff will look at it and decide whether or not want they want to hire a consultant to look of the stuff or do it themselves. And then there will be an open meeting set in which in which their staff would make their recommendation and obviously at that point in time the commissioners will have their own opinions that that would like to express. In terms of time frame, there is no statutory time frame under which they have to address this, but they do recognize that the balance continues to build up and gets more difficult for them to address it the longer they wait.

Also, on the 2 years which you file for recovery over, was that set in the settlement or is that simply the time frame you're requesting?

It was not in the settlement. That was a decision that we made.

Okay. Thank you very much.

Thank you.

Your next question comes from Paul Patterson with Glenrock (ph) Associates.

Hi it's Paul Patterson. Can you hear me? I want to ask a follow-up on the wholesale (ph) market conditions. To the previous questions. Could you give me more color, perhaps, of what you think is driving the market? We have had some outages, and we have had (inaudible) very hot weather etc., and tight reserve margins in Southern California etc. You guys mentioned that really you're not seeing the spark spread response that one might think for those. I was wondering what you think is actually driving the market? I'm sorry if I miss that if you answered that already, but I missed it if you had.

No that's okay and I think it was Zach that teed it up. Zach Schreiber first, but I can add a little bit. When we talk about the numbers, or at least when I do I am talking about the average for the quarter. I can find a number of hours where sparks have blown out to the 30 and $40 range. But that's fairly limited instances and tends to be on very select days on select hours of the afternoon. So, when I talk about the on-peak period, I'm looking at the whole on-peak period as opposed 1 or 2 hours or even the super peak. But it tends to be driven by the capacity situation. Overall, we will have points in time during the day, either through capacity constraints or transmission constraints in particular areas where you'll see a spike. But, a few hours here and there doesn't make a quarter or a month.

Right. Now going forward for this year, particularly for the summer and particularly I guess we really read more about California, and the low reserve margin that is there and the concerns about reliability and stuff. Are you seeing the same things that are out there looking forward next few months and what have you in a year or -?

Forward price is relatively moderate.

Okay. And the reason for this essentially is because I guess it is that competitive in general, and although there are sometimes where you get some constraints it isn't enough to change the whole picture on average is that correct?

Exactly.

I appreciate it thank you.

Your next question comes from Reza Hatefi, Zimmer Lucas Partners

Good morning, thanks for taking my call. You mentioned 4% customer growth. Are you still maintaining some what of 5% load growth?

The actual energy growth is a little over 4% a year.

A little over 4%. About the had just, you mentioned 85%, could you give some color on prices of your gas hedges?

Well, as far as I would want to go principally for competitive reasons they are substantially below forward market prices.

I guess it was on the fourth quarter call if I'm not mistaken you said 70% for '05 and 30% for '06 so - if I'm not mistaken on those numbers meaning that you hedged about 40% of your '06 gas in the last 6 months or so. Am I correct on that and then I could maybe extrapolate my own estimate of maybe where you hedged it?

That sounds about right.

Okay. And - just something with the guidance, maybe I missed this are maintaining guidance but you're still including Silver Hawk losses in there?

Correct.

Okay. And I guess with the coming rate case filing, all the issues surrounding the PSA, including the $786 million number, the $20.74 per megawatt hour, and up 4 million band, they can all be adjusted or all 3 of those will be the hot topics in the case. It is that basically what is going on?

I am not sure they will be hot topics. They will be one of the topics and it will all be addressed in the rate proceeding.

Okay great. Thank you.

[Operator Instructions].

Your next question comes from John Hanson with Imperium.

Just a little bit on the general rate case coming up. Can you talk about the timing of that and any drivers and constraints on the timing of that and any drivers or constraints on the timing of that filing?

This is Jack. What I can tell you is that it will be in the fourth quarter we haven't picked an exact date yet. The issues in the case will be less volatile than the one we just finished. And one of the bigger ones we all know about of course is Sundance, and then you have all the other issues in a rate case that you normally have. Things like O&M expenses, reliability expenses those kinds of things. This will be more normal kind of rate asking, if there is such a thing.

Do the high gas and power prices and deferrals affect the timing of that case in any way?

You mean the timing of the filing of it?

Right.

No, it will not. It is not best to have a fuel adjustment request sitting in front of them at the same time you file a rate case, but I don't think we have an alternative.

Good luck. Thanks.

Thank you.

The next question comes from Ashar Khan at SAC Capital.

Hi good afternoon. Jack could you be more specific on the real estate update? I heard you might be coming into town late August early September. Is that the time frame or is it more like November? Could we get a better sense of when we will get exactly that update?

I think you're accurate. We will be out on the east coast later next month. But as Bill said, we will be addressing the subject of SunCor later this year.

So, that will be later this year, more like November or something in time frame?

Just later this year. We have not nailed the date down, Ashar.

Secondly, can this happen with the timing of the rate case that if the RFP comes in and the lower choice thing is an asset that you can buy, that you can get the approval of that asset, and that asset can then be, according to the rate request coming in at the end of the year, and hence the rate filing could be for Sundance and the asset that you bought? Can that happen or no?

Well, I guess, I never say never, but I would say highly unlikely that scenario will play out. You realize we'll have a request sitting there and if we want to purchase an asset it will have to be a whole background investigation on the request for the purchase of the asset, and that just will not take place in that short a period.

Then, what will happen, then you will have to file another case in '07 to get that asset and rate case?

I thought you were talking about the time you file it. There is nothing to prevent us if to say that they approve the purchase of an asset, that would prevent us from amending our existing re-filing.

So, you can amend your existing rate filing?

Absolutely.

Okay. So, that's what I was trying to think of so, by the time you get to rate case decision in '06, at the end of '06 the amended rate case filing could have both assets in rates starting in '07.

It could but you're making the assumption that in face, our choice would be to purchase an asset and I have never...

... no I understand. That is my assumption.

Okay.

Under that assumption, that can work out?

That could.

Okay. What does a 1% growth translate into earnings? Is there a benchmark we could use going forward that -- I guess you mentioned it is $0.08 per 4% in the quarter. Could we say it's like $0.32 for the year of 4% growth rate in kilowatt hour usage is to the net income line?

One, no, I do not have of ballpark rule of thumb, but your extrapolating one quarter into the full year. I suspect that is probably fraught with error, but specifically to your question I do not have that number.

Okay. Don, as you look at next year I guess the positives are that a portion of the rate request that is not in for the first quarter, am I correct that interest expense should be lower because you are as you said, your taking out debt at the parent at the utility?

Yes.

And then there should be growth in the utility business, and the negative the only negative I see is from SunCor which you will let us know at the end of the year. Is that a fair way to summarize it?

Well, you jumped in with the negative, but I think when we address our outlook for '06 is probably the better time to put it all together, the pluses and minuses.

Okay. I know you mentioned it on the announcement in the first quarter that it came out ahead of plan. Did the second quarter come ahead of plan or on expectations?

We are very much on plan.

Okay. Thank you very much.

Thank you.

You have a follow- up question from Zach Schreiber with Duquesne Capital Management.

Actually my question has been asked and answered. Thank you.

Okay, Zach. Thanks.

At this time there no further questions. Are there any closing remarks?

Just thank you. As I said earlier, we know it is a busy time and we thank you for your attention. Thank you very much.

This concludes today's Pinnacle West Second Quarter 2005 Earnings Call. You may now disconnect.